Question

What is difference between capitalisation and capital structure and financial leverage

Answer 1

Funds are the basic need of every firm to fulfill long-term and working capital requirement. 

Financial structure - The combination of long term and short term financing represents the financial structure of the company. It implies the way assets of the company are financed, i.e. it represents the whole liabilities side of the Position statement like the Balance Sheet, which includes both short-term and long-term debt and current liabilities. It includes Equity capital, preference capital, retained earnings, debentures, long-term borrowings, account payable, short-term borrowings etc.

Capital Structure - The combination of long-term sources of funds, which are raised by the business is known as Capital Structure. It covers only the long-term sources of funds. It is usually considered to be a subdivision of Financial Structure. It includes Equity capital, preference capital, retained earnings, debentures, long-term borrowings etc.

Financial leverage - It is the amount of debt that an entity uses to buy more assets. It is considered as a factor at the time of designing the financial structure: Leverage can be both positive or negative, i.e. a modest rise in the EBIT will give a high rise to the EPS but simultaneously it increases the financial risk. It is the amount of debt that an entity uses to buy more assets. Leverage is employed to avoid using too much equity to fund operations. An excessive amount of financial leverage increases the risk of failure, since it becomes more difficult to repay debt.

Answer 2

Capitalisation

a. It is a quantitative aspect of an enterprise's financial planning.

b. It refers to the total amount of securities issued by a firm.

Capital structure

a. It is concerned with the qualitative aspect.

b. It refers to the types of securities and their proportionate amounts which makes up capitalisation. A firm can issue three types of securities. They are Debentures, Equity shares and Preference shares. The capital structure of an enterprise refers to the decision about the proportion of these securities.

Some people include even the proportion of short-term debt in capital structure. They refer to the capital structure as financial structure.

Financial structure

a. It refers to the entire liabilities side of the balance sheet.

b. It consists of a specified percentage of short-term debt, long-term debt and shareholder's funds.